Matt Stankiewicz, Partner at The Volkov Law Group, concludes his blog series on FTX by highlighting some of the most interesting facts from the firm's recent bankruptcy filing.
In addition to all the legal trouble for FTX founder and CEO Sam Bankman-Fried ("SBF"), the company also filed for bankruptcy and SBF was removed as CEO. John J. Ray III, an attorney and bankruptcy professional, assumed the role of CEO to guide the company through these proceedings. Interestingly, Mr. Ray is the same lawyer who served as president of Enron Creditors Recovery Corp., the company tasked with recovering funds from Enron's creditors after the famous scandal.
Bankruptcy proceedings are worth discussing, as initial fillings indicate a litany of compliance failures, failures so flagrant and so ludicrous that compliance professionals will simply shake their heads in disgust. Part of this discussion is for entertainment purposes only. Otherwise, it also features a look at a company that grew too fast and thought itself untouchable. Some of this material may be a good source of relevant examples for your next training session.
In its initial filing, FTX indicated that it has more than 100,000 creditors with liabilities in the range of $10 billion to $50 billion. All of FTX's various businesses were included in the proceedings, including FTX US. Prior to the filing, SBF had indicated that FTX US was fully solvent. However, it turns out that, as with most of SBF's statements, this was not entirely true and as such, US clients are now in limbo as proceedings move through the court system.
In a November 17, 2022 court filing, Mr. Jay outlines a variety of internal control failures that led to the company's demise. Remarkably, the man who oversaw the Enron scandal stated in no uncertain terms that this situation was the worst he had ever seen:
Never in my career have I seen such a complete failure of corporate controls and such a complete absence of reliable financial information as here. From the integrity of compromised systems and flawed regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised people, this situation is unprecedented.
When you see a statement like that, especially from the guy who came to clean up Enron, you know the rest of the presentation is going to be interesting.
My personal favorite comes from the discussion of payout controls. FTX employees submitted reimbursement requests via an online chat platform, where various supervisors would approve disbursements solely through the use of various emojis. Many of these chat logs were set to automatically delete after a certain amount of time, so some logs could not be recovered. Additionally, many of these transactions were for personal loans to employees used for real estate or other personal items. Many of these so-called loans lacked formal documentation, despite having significant value. SBF itself received a $1 billion loan, while another executive, Nishad Singh, received $543 million.
Coming a close second behind the refund policy is the fact that FTX apparently did not keep track of the employees that worked for the company. The presentation states that โ[a]At this time, the Debtors have not been able to prepare a complete list of who worked for FTX Group as of the Petition Date, or the terms of their employment.โ This also means that there were no clear lines of responsibility between employees and no way of knowing who was reporting to whom.
Furthermore, FTX did not have any kind of sophisticated cash management system and did not maintain centralized control of its cash. Apparently, the company did not even maintain an accurate list of bank accounts controlled by the company. At a high level, the company had no way of knowing how much cash they had on hand at any given time. This is also likely due to the fact that much of their decisions were made through chats that were deleted after a set period. Considering how often they tapped into client funds for various reasons, they probably weren't concerned about these accounts, as they always had access to liquid assets.
The new CEO raised substantial concerns regarding the audited financial statements of several of the companies. The filing noted that FTX relied on an auditing firm Prager Matis, which bills itself as the "first CPA firm to officially open its Metaverse headquarters on the metaverse platform Decentraland." In addition to these statements appearing to be totally unreliable, FTX did not even have a formal accounting department despite the size and scope of the company. Instead, they outsourced the entire function and relied on Quickbooks for day-to-day operations. Surprisingly (or maybe not so shocking considering everything we've learned up to this point), "[b]Balances of deposited clients' crypto assets were not recorded as assets on the balance sheet and are not presented.โ
